ZTE – Software not silicon

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ZTE could lose Google.

• I think that ZTE’s real problem from its 7-year ban on acquiring technology from US companies, will be its inability to ship Google Ecosystem devices which could decimate its business outside China.
• According to Counterpoint Research (see here), ZTE shipped 44.6m Android smartphones in 2017 of which around 10.9m were sold in China.
• 49% of these devices used a Qualcomm chipset (Counterpoint) and now all roadmaps using the Qualcomm chipsets will have to be scrapped.
• This is an obvious advantage for MediaTek which looks like it will sell an extra 25m chipsets per year however I think that there is a risk that ZTE loses all of its non-Chinese Android business.
• This is not because MediaTek does not make good chips, but because there is a distinct possibility that ZTE will no longer be able to make devices that run Google services.
• The basic operating system of Android is open source and although it is US made, there is nothing that can prevent ZTE from getting its hands on it.
• However, the same cannot be said for Google Mobile Services (GMS).
• This is the proprietary layer that sits on top of Android and contains the Google Play app store as well as services like Gmail, maps and so on.
• Although ZTE, does not pay cash for this software, it is payment in kind, as it receives technology and traffic acquisition cost in return for distributing Google’s technology.
• Hence, I think it likely that GMS software will be covered by this ban, meaning that ZTE will not be able to produce GMS compliant handsets.
• In almost every region outside of China, it is almost impossible to sell an Android handset that does not have Google Play installed.
• Consequently, I see a real possibility that ZTE will no longer be able to make phones for regions where it currently sells 75% of its volume.
• This will trigger a loss of market share from which it is unlikely to ever recover.
• The main beneficiaries here will be Huawei, Samsung, Oppo, Vivo and Xiaomi all of whom will be circling like vultures to pick up the share that ZTE relinquishes.
• The real losers here are the smaller suppliers who are disproportionately exposed to ZTE like Acacia Communications and Lumentum Corp.
• Qualcomm, Broadcom, Google and the like have a large enough spread such that they will be able to offset losses at ZTE with increases in orders from those that pick up its share.
• Given the gravity of this situation, when ZTE stock re-opens, it is very unlikely to be a bargain and I would use any recovery of relief to reduce positions.